How the State makes medicine more expensive

The decision of Martin Shkreli, the executive director of Turing Pharmaceuticals, to multiply the price of Daraprim, a drug used to treat malaria, toxoplasmosis or HIV, 55-fold has been one of the most notorious pharmaceutical scandals of recent days. The price of a Daraprim pill has gone from 13.5 USD to 750 USD. If the figures seem shocking, add to this the fact that a single Daraprim pill costs less than a USD to produce: in fact, they’re sold in India for about five cents each.

Many have complained that this practice sums up all the evils of capitalism: the unbridled pursuit of profit at the expense of multiplying the price of all products, thus reducing their accessibility to the poorest and neediest in society. However, one should start by asking how it’s possible that a product with a production cost of a mere few cents can sell for 750 dollars without any other company competing against it simply by selling cheaper. Is this same rampant pursuit of profit which leads Shkreli to multiply the price of Daraprim 55-fold not leading other entrepreneurs to try to snatch up buyers by bringing down the sale price?

Patents are usually the main obstacle to competition in the pharmaceutical market: a patent is a set of rights granted by the State exclusively to the creator of a new product or a new technology, so they can commercially exploit it. Patents are therefore monopolies on ideas, which consequently allow monopolistic producers to charge sales prices well above their production costs.

However, in the case of Daraprim, the lack of competition which prevents disproportionate price increases cannot be attributed to the existence of patents: Daraprim is a generic medicine and therefore anyone should be able to manufacture and market it. Why then with such disproportionate profit margins doesn’t everybody do it? Some economists claim that the problem is the low demand for this drug, estimated at 8,000 and 12,000 units per year: if the profit margin is huge but its volume is very small, companies won’t have any incentive to launch a substitute. But the profits from marketing Daraprim in 2014 amounted to 10 million dollars, an amount that would increase substantially should Shkreli carry out his threat to increase the price 55-fold and that should therefore attract competition.

The low sales volume is not an argument in itself to exclude competitors. There is perhaps another more relevant problem: in order for potential competitors to market drugs which are Daraprim substitutes, it’s necessary that they receive the label of a generic equivalent by the FDA (the US regulator), but if the selling price of Daraprim is soaring, the costs of carrying out the clinical trials required by the FDA will also be extraordinarily expensive (it is what is known as a closed distribution). In a way, then, Turing Pharmaceuticals would eliminate competition using the same mechanism that was drawing it in: the high prices of Daraprim spark competition, while it becomes harder for the competition to develop substitutes to compete.

Let’s focus on the fact that, if this was the case, the ultimate justification of the monopoly power of Shkreli would come from state regulation: only medication authorised by the FDA can compete with those already commercialised, even when their patent has expired. If the FDA expands or artificially raises the cost of the approval process, the previously approved drugs will have a temporary monopoly that will allow them to charge almost any price to their customers. In a free market there would be various private accreditation agencies committed to certifying the safety of a drug, making the process of accreditation much cheaper and faster in every way. Perhaps many are wary of such a model and still prefer accreditation by public bodies, but even a moderated pharmaceutical model could be more liberalised than the current one: for example, if a generic equivalent of Daraprim has been accredited (as it was) by European public supervisors, why not allow its marketing in the US so it can compete with Turing Pharmaceuticals? That is, although one may be suspicious of private accreditors, there is little reason to prevent multiple and competing supervision among state accreditors.

But the real reason for the lack of competition in Daraprim is not the closed distribution but rather a recent regulation by the FDA. In the US, those medications which were already produced and sold before 1962 can continue to be marketed with the same labelling and composition without the need to submit to the accreditation process of the FDA (what’s known as grandfathered drugs). So far nothing strange: if the medications which were developed before the present controls and were being marketed for decades have had no visible side effects there is no reason to prevent their sale. However, since 2006 the FDA has created a new and absurd rule: if a private company submits any of these exempt medications to the current accreditation process since 1962, the FDA will grant the company an exclusive marketing right (a category similar but not identical to patents).

This is exactly the problem: in August this year, Turing Pharmaceuticals bought the exclusive distribution rights of Daraprim from Impax Laboratories for some 55 million dollars and multiplied its price within a few weeks. We should recognise how state regulations create artificial shortages even listed on the market: Impax Laboratories had followed the procedures so that the FDA could grant them the exclusive distribution rights, and it later sold this state licence for some 55 million dollars to a businessman who bought those rights thanks to the ability granted to him to exploit consumers.

Ultimately, it’s the FDA-generated regulatory framework that creates artificial monopolies, allowing the prices of medications to multiply without competitors emerging. Without the FDA there wouldn’t be exclusive distribution rights or closed medical distribution rights, that is, in a free, deregulated market, competition would be a much more vigorous and the price margins of the generics tighter. One can defend the need for the FDA and its procedures which allegedly provide better guarantees, but we can’t attribute these adverse effects to the free market: the FDA -justified or unjustified, that’s another debate altogether- destroys the free market of pharmaceuticals. Thus the consequences of the FDA abolishing the free market is attributable to the FDA, not to the capitalist free market.

Martin Shkreli, and his greedy abuse of Daraprim users, is a product of statism, not of liberal capitalism.

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